American Railcar Industries, Inc. (NASDAQ:ARII) Q4 2015 Earnings Conference Call February 19, 2016 10:00 AM ET
Jeff Hollister - President and Chief Executive Officer
Luke Williams - Interim Senior Vice President, Interim Chief Financial Officer and Treasurer
Matt Brooklier - Longbow Research
Justin Long - Stephens Inc.
Matt Alcott - Cowen and Company
Art Hatfield - Raymond James
Willard Milby - BB&T Capital Markets
Steve Barger - KeyBanc Capital Partners
Tyson Bauer - KC Capital
Mike Baudendistel - Stifel Nicolaus
Good day ladies and gentlemen and welcome to the Q4 2015 American Railcar Industries Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions].
I would now like to introduce Jeff Hollister, President and CEO and Luke Williams, Interim Senior Vice President, Chief Financial Officer and Treasurer. Mr. Williams, you may begin.
Thank you. Good morning. I'm Luke Williams, Interim Chief Financial Officer and I would like to welcome you to the American Railcar Industries fourth quarter 2015 conference call. For those who are interested, a replay of this call will also be available on our website, americanrailcar.com shortly after this call ends.
Joining me this morning is Jeff Hollister, our President and Chief Executive Officer. Our call today will include comments about the railcar industry, our operations and financial results. Following these remarks, we will have a Q&A session.
This conference call will include forward-looking statements, including statements as to estimates, expectations, intentions and predictions of future financial performance based on currently available information. Participants are directed to our SEC filings and press releases for a description of certain business issues and risks, a change in any one of which could cause our actual results or outcomes to differ materially from those expressed in the forward-looking statements. Also, please note that the company does not undertake any obligation to update any forward-looking statements made during the call.
EBITDA and adjusted EBITDA are non-GAAP financial measures we will discuss today, that are reconciled to net earnings in our press release that was issued yesterday. The press release is available through the Investor Relations page of our website.
Now it is my pleasure to introduce Jeff Hollister.
Thanks, Luke. Good morning to everyone. Thank you for joining us this morning. I'd like to start by introducing you to Luke Williams, our new Interim Senior Vice President, Chief Financial Officer and Treasurer. Luke joined ARII back in 2006 and since then has served in various roles while gaining experience in all three of our business segment.
Most recently, he served as Vice President of Finance and Chief Accounting Officer working closely with Umesh Choksi, our former Chief Financial Officer. His experience in various matters including financing treasury functions, financial planning and analysis, investor relations, SEC reporting and compliance, planned accounting operations and other accounting matters will continue to benefit ARII. We are pleased to have him in this new role. 2015 marked another record year of deliveries for ARII and the industry as a whole.
We were able to capitalize on these historically high levels by achieving record-breaking results for the fourth consecutive year. With record earnings from operations and record earnings per share. As the industry experts predict, a reduced number of total deliveries over the next several quarters. We would like to emphasize the effect of our diversified model has had on our business.
Our lease fleet has more than doubled in the past two years. Reaching 10,362 railcars at December 31, 2015. In addition, we continue to focus our efforts on further expanding our railcar repair network. These two segments serve to complement our core business, manufacturing. And support us, during periods of more normalized levels of demand.
The industry backlog at December 31, 2015 at 111,019 railcars remains in excess of historical average levels. At approximately 80% of the backlog is for tank and hopper railcars, our primary products. The industry reported that 9,169 railcars were ordered and 20,296 railcars were delivered during the fourth quarter of 2015. Producing a book-to-bill ratio of almost 0.5 to 1.
The FTR rail equipment outlook for North American railcar markets known as FTR. Currently expects new railcar deliveries to start trending downwards from these high levels. However, a significant portion of deliveries in 2016 are expected to be for both tank and hopper railcars.
We believe, the tank railcar market is softening driven by multiple factors including record high deliveries of tank railcars in recent years. Recent volatility in oil prices, as well as uncertainty surrounding the May 2015 release of regulations related to tank railcars in the US and Canada.
Customers continue to weigh the cost versus benefit of investing in new tank railcars or modifying their existing tank railcars for flammable service. The combination of these factors has led to reduced demand for railcars in the energy sector. Specifically crude oil tank railcars and sand hopper railcars.
While the hopper railcar market appears to have peaked in 2015 in terms of volume, we're seeing demand shift toward more speciality hopper railcar types including large cubed covered hoppers for plastic pellets. Over the past several years, we have focused our efforts to further diversify our business, so that we may better adapt to the demands of the industry and be able to withstand, the cyclical nature of new railcar manufacturing.
Our business model is designed to support the railcar industry with complete lifecycle solutions including manufacturing, as well as railcar leasing and railcar services. The flexibility of our facilities and our workforce continues to benefit us as the railcar industry is ever evolving and demand continues to shift.
I'll now turn it back to Luke for a discussion of the fourth quarter and full year 2015 financial results.
Thanks, Jeff. Fourth quarter 2015 consolidated revenues were $261 million, up 73% versus $151 million for the same period in 2014. The increase was driven by higher revenues for all three of our segments. With the largest dollar increase in our manufacturing segment. We shift 1,885 direct sale railcars and 45 railcars to our leasing customers during the fourth quarter of 2015.
This was compared to 893 direct sale railcars and 1,224 railcars to leasing customers during the fourth quarter of 2014. Consolidated manufacturing revenues were $210 million for the fourth quarter of 2015 compared to $112 million for the same period in 2014. The primary reason for the increase was higher volume of direct sale railcar shipments partially offset by lower average selling prices, due to a higher mix of hopper railcars and a decrease in revenue from lower material cost, for key components and steel that are generally passed through to customers.
Direct sale shipments increased by 992 railcars in the fourth quarter of 2015 compared to the fourth quarter of 2014. Consolidated manufacturing revenues excluded estimated revenues related to railcars built for our lease fleet of $5 million for the fourth quarter of 2015 compared to $150 million for the same period in 2014 and reflected a higher mix of railcar shipped for direct sales.
The higher mix of railcar shipped for direct sales versus lease, is primarily driven by increased demand for speciality hopper railcars and those customers preference to buy rather than lease railcars. Because revenues and earnings related to lease railcars are recognized over the life of the lease. ARII's quarterly results may vary depending on the mix of lease versus direct sale railcars that we shipped during that given period.
Railcar leasing revenues increased to $33 million in the fourth quarter of 2015 compared to $22 million for the same period in 2014. This increase was primarily due to the increase in our lease fleet from 7,730 railcars at the end of 2014 to 10,362 railcars at the end of 2015. Railcar services revenues were $18 million in the fourth quarter of 2015 compared to $17 million in the same period of 2014.
Revenue increased due to an increase in demand and a favorable change in the mix of work at our repair facilities. Consolidated earnings from operations for the fourth quarter of 2015 were $62 million compared to $42 million for the same period in 2014. The increase was primarily due to increased earnings across all three of our segments with the largest dollar increase in the manufacturing segment driven by a higher mix of direct sale shipments relative to railcar shipped for our lease fleet, as I mentioned earlier.
Our consolidated operating margins were 24% for the fourth quarter of 2015 compared to 28% for the fourth quarter of 2014. This decrease was primarily due to higher mix of direct sale hopper railcar shipments, which generally sell lower prices than tank railcars due to less material and labor content.
Manufacturing earnings from operations were $42 million and 20% of revenues for the fourth quarter of 2015 compared to $28 million and 25% of revenues for the same period in 2014. Segment earnings from operations excluded $3 million, an estimated profits on railcars built for our lease fleet for the fourth quarter of 2015 and $43 million for the same period in 2014.
The estimated profits on railcars built for our lease fleet are eliminated in consolidation. Railcar leasing earnings from operations were $23 million for the fourth quarter of 2015 compared to $15 million in the same period of 2014. This increase was due to the growth in the number of railcars in our lease fleet.
Railcar services earnings from operations increased $1 million compared to the fourth quarter of 2014 primarily due to the increase in revenues driven by increased demand and a favorable change in the mix of the work.
Selling general and administrative expenses increased $4 million compared to the fourth quarter of 2014, primarily due to increase shared-based compensation expense. Legal and compliance cost, higher depreciation related to our new enterprise resource planning system and changes in other corporate expenses.
Adjusted EBITDA which excludes share-based compensation expense was $76 million for the fourth quarter of 2015 compared to $53 million for the same period of 2014. This $23 million increase was primarily driven by increased earnings from operations for all three of our business segments.
Interest expense was $6 million for the fourth quarter of 2015 compared to $2 million for the same period of 2014. The increase is a result of higher average debt balance and a higher weighted average interest rate as a result of increased borrowings to support the growth of our lease fleet.
The increased interest is expected to be offset by the additional revenue generated from railcars added to our lease fleet. Currently, the majority of our debt has a fixed interest rate thereby minimizing the effect of any potential rise in interest rate.
Net earnings for the fourth quarter of 2015 were $36 million or $1.82 per share compared to $23 million or a $1.06 per share in the fourth quarter of 2014. Total consolidated revenues for 2015 were a record $889 million, an increase of 21% compared to $733 million for 2014. Revenues increased as a result of higher mix of direct sales shipments relative to railcar shipped for our lease fleet. Increased railcar services revenue and an increase in revenues from our lease fleet.
Manufacturing segment revenues were $1 billion for both 2015 and 2014. In 2015, we had record shipments of 8,903 railcars including 2,633 railcars to our leasing customers compared to shipments of 8,018 railcars in 2014 which included 3,291 railcars to our leasing customers.
Adjusted EBITDA was at a record $279 million for 2015 compared to $209 million for 2014. The $70 million increase was driven by record high earnings from operations and improvements from our joint ventures. Net earnings for 2015 were also at a record $134 million or $6.39 per share compared to $100 million or $4.66 per share for 2014.
As of December 31, 2015 we had net working capital of $273 million including $298 million of cash and cash equivalents. Our strong earnings contributed to cash flow from operations of $265 million in 2015. Additionally, we received net proceeds of $321 million in 2015 from our lease fleet financing.
We invested $212 million in 2,633 new railcars for lease in 2015. In December, we closed on a revolving loan with borrowing availability of $200 million. We initially drew $100 million under this facility. But in evaluating our short-term cash needs and with the strength of our balance sheet. We were able to repay a revolving loan of $100 million in February 2016 bringing our capacity to borrow under this facility to its original amount of $200 million.
We have additional unencumbered railcars available to further leverage our lease fleet, as we find opportunities to strategically grow. During the fourth quarter of 2015, we repurchased 167,000 shares of common stock at a cost of $6 million under our stock repurchase program for a total of 1.5 million shares of common stock repurchased during 2015, at a cost of $57 million.
Subsequent to December 31, we have further utilized our current liquidity to repurchase an additional 146,000 shares under our stock repurchase program at a cost of $6 million. Board authorization for approximately $187 million remains available for further share repurchases.
On February 17, our Board of Directors declared our 14th consecutive quarterly cash dividend. Our profitability, cash flow and financial condition allowed ARII to return $91 million during 2015 directly to our stockholders through our quarterly dividends of $0.40 per share as well as through stock repurchases. We cannot guarantee that we will continue to pay dividend or engage in stock repurchase in the future.
At this time, I would like to turn it back to Jeff for a few comments about our potential growth opportunities and joint ventures.
Thanks, Luke. Going into 2016, we expect the flexibility of our manufacturing and repair operations to better enable us to respond to changes and customer and industry demand. With a recent completion of several capital projects, we continue to strengthen our manufacturing flexibility and increase repair capacity.
For example, we now have the ability to retrofit up to a 1,000 tank railcars a year at our Marmaduke tank railcar facility. In the near term, we intend to use this additional capacity to meet the increased demand for traditional repair work. Thus increase in our flexibility and expanding our existing repair networks to respond to demand, opportunities that we expect to arise.
While our railcar leasing and railcar services segment may not completely offset the softness in the new tank railcar market. We remain focused on efficiently manufacturing high quality railcars and responding to our customers need. We expect production at our hopper railcar facility to remain strong over the next several quarters. As it shifts to more specialty railcar types.
Our current capital expenditure plans for 2016 include projects that we expect will further expand our capabilities as well as maintain equipment, improve efficiencies and reduce cost.
Railcar leasing has become a significant contributor to our earnings and we remain focused on the growth of this business, as our fully utilized lease fleet generates revenue streams over the life, of the railcar. We continue to support the growth of our lease fleet through financing.
As demonstrated by our revolving credit facility recently secured in December. We continue to be strategic in our selection of orders for railcars that will be added to our lease fleet versus direct sales. Targeting strong customers, certain railcar types servicing select commodities and favorable lease terms and rate.
As of December 31, 2015 our backlog includes 1,452 railcars to be manufactured for lease. Our two joint ventures Ohio Castings and Axis continue to provide us benefits by supporting our railcar manufacturing operation. Our Axis joint venture had its best year yet, with record-breaking revenue and earnings as its operations continue to improve in terms of efficiencies and profitability.
Ohio Castings production level is consistent with our expectations, as it continues to provide us with key component. With our joint ventures producing critical parts for both tank and hopper railcars as well as other railcar types, we expect their contribution to continue to be driven by industry demand for all railcar types.
The recent implementation of our new Enterprise Resource Planning, our ERP system during the third quarter of 2015 is expected to improve the efficiency of our supply chain through improved inventory management and other improvements related to certain financial and transactional processes.
In 2016, we plan to complete the second major phase of this project by implementing it for our railcar services segment, which is expected to provide further integration among all our manufacturing and repair faculties, as well as provide additional improvements in the future.
Now I'll turn the call back over to the operator. We'll be happy to take your questions. Operator, would you please explain how our participants can register the question?
[Operator Instructions] our first question comes from Matt Brooklier of Longbow Research.
So I wanted to talk about 2016 and your expectations for railcar deliveries. We got some color from your competitor, yesterday aftermarket. They took down their delivery expectations, but I'm just trying to get a little bit of sense in terms of what, deliveries could look like this year and then maybe you could talk to, we'll start with that.
Thanks for the question. We don't give formal guidance, never have. But we would like to try you guidance on what we're seeing. Obviously on the hopper car side, we're still pretty strong. We're pretty bold for 2016, the mix is changing on the hopper car side. So the volume in our hopper car plan will be down a little bit for 2016.
Obviously, we're low short on the tank car side, but the second half of the year. We still got some work to do out there. I mean, if you look at kind of our run rate the last half of 2015. We're probably trending around now 25% to 30% down on deliveries for 2016 versus 2015. But again, we're still out actively selling cars and looking to fill in some space, second half of the year.
Okay and then, I guess I'm trying to get a sense for - if seeing just further weaken and demand potentially stays at current levels or weekends. What deliveries could look like for next year and with respect to your current backlog, can you give you a little bit of color in terms of how much of the current backlog potentially delivers over the next 12 months?
I think, it's roughly around 70%, would fill up 2016. Obviously, we have some tank car orders and hopper car orders into 2017, more hopper than tank. We still feel pretty strong about the hopper car business still getting lots of inquiries for plastic pellet cars and grain and agriculture-related cars. So obviously the challenge for everybody in this market is trying to fill up the tank car capacity.
We'll say, we mentioned it in our press release and in the script. We have finished an expansion at our tank car facility, which is going to allow us to move part of that capacity in our repair business. We've got a lot of momentum going on our repair business, a lot of growth expected there. We feel like there is a bubble of tank qualifications and at some point there are going to be customers that want to retrofit cars and so we're going to be able to move that.
If we have to move that new car capacity into repair and retrofit capacity at our tank car plant, if it does go further south in 2017 or 2018.
Okay, well good to hear you have some flexibility in the model and being able to take on incremental, I guess a different type of work on the tank cars. And I guess my last question and I guess you kind of alluded to in your answers. But I'm trying to get a sense for regulations and retrofits this year. It seems like, there hasn't been a lot of momentum in terms of market participations, retrofitting their cars. I'm just trying to get some incremental color in terms of what that could look like, this year and if we have any sense as to, when that activity, could pick up?
We had very little activity in 2015, we went ahead from an engineering standpoint. We've developed our retrofit plans on the two or three key car types that we feel will be retrofit. We've tested two cars down at our Marmaduke facility. We've tested two cars up at the ACF Milton facility that we partnered with them.
So from a capability standpoint, we're ready to go. Just in the last three or fourth months. We have seen a little more activity on the retrofit. I think some of the companies the shippers that own cars. Realize, if the cars are going to support their business. They're going to have to do this retrofit and so we're actually are starting to see more and more activity as far as inquires.
We've had three or four customers down at our plants touring asking questions. We've got formal proposal starting to come through on that. So we're starting to see a little activity there. Whether they pull the trigger and retrofit these cars. The second half of this year, whether it goes into 2017. I think the Jury is out.
A lot of the leasing companies, probably a little more of a holding pattern now. Obviously most of the dates out there. They're still several years before someone has to do anything, but if everybody waits till the very end, there is going to be a rush to get it all done, the last two year to [indiscernible].
Thank you. Our next question comes from Justin Long with Stephens Inc.
I wanted to ask a question about the lease fleet. Obviously it's grown substantially over the last few years, but is there any color you can provide on where the mix stands in terms of different car types within the lease fleet today? And then also, as you look at that lease fleet, could you comment on the level of renewals that are coming up in 2016?
Thanks for the question, Justin. As far as the mix goes, we're about two-thirds tank, one-third hopper. We've got a variety of commodities that those fleet [ph] cars are serving north of somewhere 12 to 15 range. So as far as renewals go, we've got a little exposure in 2016 about over 400 cars, they are around 4% of the fleet and then it ramps up a little bit more in 2017 and 2018. So not a big exposure in the coming year, but a little bit, couple of years thereafter.
Okay, great. That's really helpful and sticking with the lease segment, how should we be thinking about the growth profit margins in that segment over the long-term. I know, they've been pretty elevated recently, you were close to 70% in 2015. But as the market retreats down from peak levels. What is it more normalized gross profit margin look like in that leasing segment?
We do have some higher lease rates in our fleet, we're in the high 60%. We came in at 70% gross profit margin for that segment in the fourth quarter. So the thing to remind you on that is, we've got obviously relatively new fleet with average age of about two years. So there is very little maintenance expense on these railcars currently. So as we move forward, we would expect to see some maintenance expense on these cars and that would definitely bring the margins down in the lower 60s.
Okay, great and then, one last one is follow-up to the earlier question. You mentioned that production on the hopper side should remain pretty strong. You're pretty full for this year. But the mix is changing to become more weighted towards some of the larger hopper cars. How does that change in mix impact margins? Are the larger hopper cars or those that at lower margin percentage in some of the smaller hopper cars you've been building recently, vice versa how is that all going to play out?
Justin, thanks. This is Jeff. No actually, the speciality larger cars have a higher margin than there is the smaller pricing cars that we build a lot of in 2015. So you're going to lose some quantity by building the larger cars, we just can't build as many of those, as they can with smaller cars. But the incremental decrease in margin, our revenue is not going to be proportionally.
It might be a little less just because we can't build enough of them, but the margin percentage is actually going to be a little higher.
Perfect, that's really helpful. Thanks for the time today, guys.
Your next question comes from Matt Alcott with Cowen and Company.
So you guys had solid results in a challenging environment. But 2016, is going to be challenging for pretty much everyone. I'm trying to get a sense of in your conversations with customers. How much of the tempered order level that are expected for 2016 are stemming from a kind of wait and see approach versus definitive cuts to CapEx plans [ph]?
I think, it's a complicated question. I mean, obviously the energy market and everything related to that is in a little bit of a holding pattern now. So obviously, the jury is still out on that commodity range. But we never really increased our capacity to our tank car market, when the market took off. We built flexibility into our plants.
So we're still continuing to see more the traditional type commodities, replacement demand coming through inquiries. Unfortunately those quantities and those orders are lot smaller than some of the big energy orders that we saw the last couple of years.
So we're still getting some volume of inquiries and we think that will continue through 2016. But obviously the market is softening, smart buyers are going to wait till they really need cars before they order them. But we still feel there is a some small pockets of inquiries and orders that are going to come through on the tank car side.
Okay and have you guys notice any shift in shippers approach to getting down tank cars up to the new regulation standards. Has there been a shift in whether people are leaning more towards retrofitting the cars or placing orders for new cars. Has there been a shift in the past three months in those?
I don't know if there's been a shift. I think, what we see is, shippers that have some of the older cars, the legacy 111 cars. They're in the holding pattern with those cars and the jury is out, whether those cars will be strapped or whether they're going to spend the money to retrofit those cars. And we're really not getting many request to look to do that in our retrofit shop. But the shippers that have the 1232 cars, the cars have been built since 2011, they'd have to have either jacket put them on or some type of modification.
We are getting inquiries and talking to customers about retrofitting those cars. So we still think, there's going to be a bubble of those cars that are going to be retrofit. The issue is, you still got several years before you have to do that for the regulation. So, we're telling everybody don't wait till the last year. So because there may not be enough capacity to get it done.
And so, we build a lot of strong companies that are in it for the long haul and starting to talk to them about getting this work done, sooner than later.
And any orders thus far this year?
We have not said that. I mean, we have gotten orders, but we don't really go into the detail on post quarter end.
Okay, great. Thank you very much.
Our next question comes from Art Hatfield with Raymond James.
You had talked about, you got 4% of the fleet up for the lease fleet up for renewal this year. Have you been able to renew any of those cars as of yet? And if so, what experience are you having on the rate change relative to the old lease?
Thanks for the question, Art. The 4% that I mentioned is, bit more in the back half of the year. So we've have started talking to those customers. But we haven't had that renewal come up yet. So it hasn't been secured. On pricing, we are seeing some softening in certain markets and definitely on the energy space. With other pockets of demand for replacement cars. Some of those markets are holding steady on rates, but we have seen some softening in pricing.
Yes to that point, Art. Most of these cars are 16 [ph] were leased out before the energy boom took off, three or four years ago. So there is not in fact real strong. There are more historical rates on those cars. So it's not like, we should see a big shift on renewal rates on those cars coming due, this year.
Great, that's actually very helpful clarification, Jeff. Thanks. Couple of - two, three other questions. You're - talking about the retrofit, I know you're in discussions and people are feeling this whole thing out. When do they do it, how do they do it? All that stuff. Have you gotten to the point, where you talking, what pricing is going to be on this stuff and really what I'm getting to is, what do you think the margin composition of this is going to be relative to what you would do on a new car build side?
Interesting question. There is a lot of different car types out there, with a lot of bells and whistles. So, every one of these retrofit programs had to be kind of looked at individually on a case-by-case basis. But I mean, when we put the expansion in our tank car facility. We set it up, more like a production facility is ran, where it's not like a job shop. It's going to run a lot smoother and a lot more efficient.
So from our mindset, the margin on that retrofit is going to be pretty comparable to an average new car running through a shop. Our normal repair services margin is around 20%. So we expected a minimum to see that on this retrofits and pushing, if we can get cost efficiencies and get it set up right and get enough volume that hopefully will be even better than that.
Okay and that is, obviously just to lower ticket than a new car, in the revenue side, right?
Yes, I mean. They could run from $35,000 to $60,000 per car dependant on the age of the car, the type of the car and what work has to be done on them.
Next thing, thanks for the help on the thoughts about production levels this year. And I know, it's tough for you to foresee the back half of the year. So your clarity was extremely helpful. And I know, obviously I'm going to [indiscernible] especially, and I know you don't give guidance. But somebody else noted, one of your peers came out yesterday.
They went to the low end of their previous guide on what builds would be, but the thing I think that probably surprised everybody was, what they said about margins and how that's going to impact us. The guidance they gave on the lower builds and I think the reduction in builds in 2016 for them is comparable to what you're talking about 2016, but they're talking about earnings being down nearly 60%.
How are you set up, do you think differently where you should not see that level of decline in earnings in 2016 given the comparable decline in production, for you to them on 2016?
I'll start and then Luke can finish it in, whatever I miss here. But, starting out I mean our hopper car facility is pretty full. Most of those orders that we'll be shipping on the hopper car side. We're taking last year and are at very strong margins. So we feel pretty good that from a margin percentage 2016 over 2015, our hopper car facility is going to be pretty comparable. Just down a little bit on volume because of mix.
On the tank car side, the orders that we already have for 2016 again, where most of those we're taking last year and we feel pretty good about the margins on those. So, the jury is out to your point, on the remaining orders that we take this year. We really, historically most of the orders that were related to the energy market, we took a lot of those and put them in to our lease fleet.
So we didn't recognize immediate margin and margin dollars on those cars. We're starting to reap that benefit now in our leasing fleet now, as we build momentum. But, so we're going to rely on more of our traditional type commodities replacement demand on our tank car side. Yes, the market is going to soften a little bit margin wise and let's face it, historical margins in 2015 and we're not going to be there. But we still feel like we're going to have a very acceptable margin on the tank cars that we get.
And our plants are set up there within 30 minutes of each other. We are very flexible on how we can run our plants. We can ramp them up, we can ramp them down, we can move people from our tank car facility to our hopper car facility. So we have a lot of flexibility there to keep our cost in line, so we can stay competitive with our pricing.
Jeff, what have you done with your labor force given the expectations for things that decline in 2016?
Yes, so we've systematically started ramping those down at our tank car facility, as our hopper car facility ramped up the second half of last year. We slowly started moving people from our Marmaduke tank car facility to our Paragould facility. Obviously, we've had a few small layoffs just because of the demands dropped little faster than we thought, but for the most part we've tried to keep all our key people busy, either working on tank cars at Marmaduke or moving them to our Paragould facility.
And then, as I mentioned we've already started doing repair work at our tank car facility, as we speak right now. So we're moving some of those people over into our other plant at Marmaduke and working on repair work.
That's very helpful. Last question and its big picture question. I'd kind of just like your thoughts on being somebody who actually works in the industry as oppose to somebody like myself who just sits on the outside and observes. This is, if we're going into a down cycle or more extended down cycle or just typical what we've seen at that. This is probably, this is the four cycle I've been through and one of the things I struggle with as I look out over the next several years.
Is, it's apparent that this global super commodity cycle is coming to an end. It's going to affect rail volumes. Additionally, we have the secular decline in coal, which could lead to better productivity, better asset turned within the rail network. So I struggle with what we may be looking at over the next few years.
And I kind of lean, I really want your thoughts on this. I kind of lean to thinking, that this downturn could be uglier than anything else we've seen particularly given the level of capacity and some of the growth, some of your peers and I'm glad, you've actively pointed out that you guys were, showed great restraint and not building out this significant adding to your tank car capacity.
It seems to be that we could be heading into a very, very difficult environment, if something's don't change within the industry. Can I get any thoughts on that thought process that I have?
Yes, I mean a lot of good points there, Art. I can't completely disagree with anything you said. I mean, obviously the energy market is very challenged and because of that and coal, obviously train speeds are up, car loads are down. It's affecting all the Class I's and all this, domino into other market. So, it is going to very, very challenging over the next few years and then that's one reason why we didn't expand our tank car capacity.
But another reason, why we've kind of converting part of that shop into repaired capacity because there is a bubble demand, at what level I guess depends on the market and businesses as a whole, but there is a bubble of demand of tank cars. They're going to have to be re-qualified and inspected and repaired over the next three to five years.
We also from a hopper car side, we're still talking to several petrochemical type companies, they still claim to be potentially needing more cars in the plastic pellet arena, over the next few years. In my mind I think looking it from a baseball analogy, we're probably into sixth or seventh inning there of the whole plastic pellet boom. So we still think, there's some opportunities there.
The Class I's play a big role in this. But our grain market cars, replacement cars, there's bubble of those cars out there. Obviously the railroads and their CapEx concerns may control more of that, but we think there's some replacement demand on the grain and agricultural side as well. So obviously more of a challenge on the tank car side.
Art, but one thing I would point out. If it gets to the level that we were in 2009, 2010, 2011. I mean, ARII we feel we're in a whole lot better shape than we were in six years ago. We've got a security blanket or a base load of lease cars 100% utilized. You put a value on those, we've got a growing repair network and business there.
And so between those, it will help offset however far the new market goes.
Thanks so much for your time, [indiscernible] and thanks for the candor. I do really appreciate it. Thanks, Jeff.
Our next question comes from Willard Milby with BB&T Capital Markets.
I just want to piggyback on maybe it was Justin's question, on lease renewals. Really appreciate the color on 2016, but was hoping you could put some numbers behind the renewals in 2017 and possibly even 2018. Just looking at, I guess Q3, 10-Q the guaranteed minimum renewals for cars lease one year more steps down about 10% to 12% between 2016 and 2017 and 2017 to 2018. So I was hoping to get a sense of, how many cars were affected by that?
Thanks for the question, Will. We've got about 18% of the fleet is up for renewal in 2017. Total, 1,800 cars in 2017.
A bit of drop spec down in 2018. And just to remind you, I mean that's overall a variety of different commodities and we have no commodity that's more than 20% of our total. So we try to stay diversified spread out and within certain customer even, say they ordered 300 cars or at least 300 cars. We'll stagger the terms over three different years and so they don't all 300 expire in one year.
All right, thanks appreciate that. And I don't know if I missed it, but did you give some thoughts around what you thought deliveries to lease fleet could be in 2016? Given that the backlog kind of stepped up here from Q3 to Q4.
We've been and I know you guys don't like we talked about here a week or two ago. From quarter-to-quarter, I think bounces around strictly based on customer demand and their preference to buy versus lease. But you can look at our historical numbers and if you look at, what's in the backlog now which I think is roughly around 20%. I mean that's a good safe average number. I mean, it could go up or down quarter-to-quarter.
Obviously, fourth quarter it was an unusual quarter where we had a lot of hopper cars for direct sale and even quite a few tank cars for direct sale. But all-in-all should average kind of what's in our backlog right now.
All right and one last thing, when you say pretty full on the hopper side, that's got a capacity about 5,000 cars, right?
Well not for 2016 because of the mix change. So it's going to be less of because of, I've always said we could probably run at full capacity 4,000 to 6,000 cars depending on the car type mix. For example, we've got all three of our production lines starting year running plastic pellet cars. So we can't run as many of those cars per day, as we can say a small cube pricing [ph] car.
And so, it's going to be something less than probably the 5,000 range and depending on what happens, late in the year, this year and we're always challenging to find a way to do more car. So if we get another hopper car opportunity out there and people need cars in 2016, we'll try to find a way to build those cars.
All right, great. Thanks for the time.
Our next question comes from Steve Barger with KeyBanc Capital Partners.
In your prepared remarks, I think you said you'll be selective in terms of the cars or customers that you're going to focus on for the lease fleet. And so my question is, are you seeing a lot of deals that you think don't meet your customer quality or asset return parameters out there in the market?
No, I wouldn't say. I think it's more we just want to be confident and who we're partnering with long-term. So we want to be careful on the credit side, but a lot of these customers are coming to us and looking for small opportunities and we're exploring everyone that comes across the dusk. But we're just being careful and making sure we're partnering with the right customer and it makes economic sense to put in our lease fleet.
At the end of the day, it's a customer decision whether they want to lease the car or directly purchase it from us. But we're being selective and just evaluating all opportunities.
Understood, if you find a deal that maybe doesn't make sense for the lease fleet, do you typically convert that to a third-party sale or is that a deal, that you would lose, most likely?
It just depends. I mean there are some opportunities that we're able, the customer looks at it either way and they'll say I'll take it for a lease or sale. But we don't typically lose per se, but it just depends on the customer's preference.
Got it and just one last question, with the market changing. Do you become more flexible on the deals that you'll take or I guess, just how does the philosophy around leasing change with the change, if it does?
Yes, as we see pricing softening, we'll definitely look at our return model and see if we need to accept some lower than we have in the past. We're definitely open to that, as the market declines and we're definitely evaluating that going forward.
To that point, I mean these are 30 years assets. So the key is, who we're partnering with and so, if you get with the right partner. Even though, the release rate maybe a little lower short-term, if they had a history of renewing these cars over the life of the assets then that takes, that comes into consideration because we're going to make our money out the life of the car, which is a lot longer maybe a different type of asset.
Right, so it's not just the price of the specific deal. It's the relationship that you can form, over a long period of time.
Okay, thanks very much.
Our next question comes from Tyson Bauer with KC Capital.
Regarding the deliveries. I think you gave a total number that's down 20% or 30%. Can we get a little bit color on that, when we look at the backlog for lease and how many cars you put in the lease fleet this past year? Is that skewed more to the reduction and cars expected to go until the lease fleet? And not as, significant over drop for third party sales, even though we have the Frac Sand situation, where we're doing the smaller cars, smaller ASP and replacing that with the much more higher ASP better margin on those plastic pellet cars.
The backlog composition [ph] to try and answer it, different way I think. The backlog composition has obviously a lot of direct sales car and as Jeff had mentioned, we're strong on hopper cars for the year. So, obviously lot of those will be direct sale. But on the tank car side, I mean it's definitely coming down and as Jeff mentioned we're looking at the second half of the year trying to see, some of the open capacity that is there, that we can fill up with orders whether those are direct sale or lease.
So I think Jeff mentioned, the 20% number as a general sense of total deliveries for the year as of, initial estimate to kind of start out the year.
Obviously when they reduced incremental increase of those lease fleet, that's expected what you've done, have you been able to determine what kind of free cash flow benefit does that creates at least in the short-term?
As I mentioned, we've got strong direct sale backlog for hopper cars and we got strength in the existing lease cars that we have the 10,300 cars that we have currently in the fleet. So we're very comfortable going into 2016 on our free cash flow and when we got committed to build for a lease in the next six to nine months.
Right, which should be lower number than what you have been running, the last couple of years. So you should see a benefit in that regard.
Last question. Have we had any discussions or any timeline in a decision that ARL is expected to make their retrofit needs for their lease fleet?
They're pretty much in the same bucket as some of the other companies, just kind of waiting and see a little bit. It's no secret that there's cars in storage now. So they're not necessarily specifically to ARL, but just in general in the market and a lot of customers are just waiting to see kind of what pricing does and demand does down the road. As Jeff mentioned, timelines are still couple of years out.
So it's still kind of wait and see and there's still little uncertainty on the regulation that are waiting to get ironed [ph] out.
[Operator Instructions] our next question comes from Mike Baudendistel with Stifel.
Just looking at the, your backlog and sort of the implied value per unit. It looks like, that's been down from what it was a few quarters ago and I just wanted to reconcile that with your comment, the hopper car should have a higher ASP. Is that just a mix shift away from tanks and towards hoppers or is there more to it, than that?
No, I think that the bulk of it is, a shift of more hopper versus tank cars.
Okay and so, then it'll be reasonable to think your, sort of ASP is going to be down meaningfully in 2016 for that reason.
I wouldn't say not necessarily go down even further. As we're actively out trying to get tank cars and hopper cars. So it depends on the mix of new orders that we get this year. One thing else, to add and I don't know the other competition and manufacturers are seeing it. We're working with our vendors, we're seeing a reduction in material cost over the last six to nine months and obviously scrap prices are down and so, overall cost are down. So therefore, selling prices are coming down some as well.
We have protection in most of our agreements. So it's all a pass through to our customers. So margins will stay the same, but selling prices may tick down just because of material cost.
Great, that make sense. That's all I have. Thank you.
And I'm not showing any further questions at this time. I would like to turn the call back over to our host.
Thank you. Before concluding our conference call this morning. I would like to take a moment to acknowledge our most important asset at ARII; our people. Our employees across the US and Canada continue to drive efficiencies both on the production lines at our manufacturing and repair facilities as well as behind the scenes and the back office. If it wasn't for these dedicated individuals, we wouldn't be boasting about our fourth consecutive record year.
I sincerely thank you for your hard work and commitment to the success of our business. I want to thank you, to everyone who participate on the call today and we look forward to another successful year in 2016. See you next quarter.
Ladies and gentlemen. So that concludes today's presentation. You may now disconnect and have a wonderful day.
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